- Medifast has great financials and a deep moat around its business.
- The company grew its quarterly dividend by almost 500% since 2016 and currently has a dividend yield of 3%.
- Due to a relatively low payout ratio and many growth opportunities, the dividend is expected to increase even further in the future.
- A conservative relative valuation of the stock reveals an upside of at least 50%.
After a 40% price drop since May of this year, I believe Medifast (NYSE:MED) is currently undervalued and has an upside of at least 50%. Below I will analyze the company’s deep economic moat and its many growth opportunities. Also by taking a deeper look at Medifast's financials, I will show that the company, besides its rapidly growing revenues, has a very stable profit structure, a debt-free balance sheet, and a very investor-friendly management.
Medifast sells diet-related food products under its Optavia brand. The company sells its products via its coaches who act as “micro-entrepreneurs”. Coaches contact potential customers, often friends or family and other social media contacts, to help them live a healthier lifestyle with the help of the company's subscription-based diet plans. For each sale, the coaches earn around 25% of the sales price as commission.
What I personally like is that the coaches don’t sell these kinds of “lose 20 pounds in one month” products, but instead try to help the clients to establish positive long-term diet changes. Obviously, the company’s idea behind that is to bind customers for longer than just one month and therefore increase the customer lifetime value.
The coaches usually don’t sell single products, but instead sell diet plan subscriptions which include breakfast, lunch, a snack, and dinner for 30 to 90 days. Monthly costs for these subscriptions are around $300-$500. I have read a few reviews about the products, and found that they seem quite average – there definitely is no competitive advantage from the product itself.
Multilevel Marketing (MLM)
Without a doubt, the whole company’s business is based on MLM. Such business models are obviously under scrutiny; however, Medifast does a really good job in making everything very professional and much less "shady" than most other MLM operations. Besides a redeemable $200 fee for new coaches, which is used for an individual website, and a starter pack that includes instructions for the coaches, there is no other down-payment needed for coaches. So coaches don’t have to buy e.g. a thousand pieces of healthy chocolate muffins, and then possibly never be able to sell them. By taking the risk away from the coaches, the company's business model has never faced any bigger problems.
90% of Medifast’s coaches are ex-customers who liked the product so much that they later joined the company as coaches as well. Therefore, Medifast has an enthusiastic workforce and at the same time doesn’t have to spend much money on recruiting, as the coaches recruit coaches themselves (just like in any other MLM, coaches who recruit other coaches, also get a small share of their newly hired coaches).
Based on the quickly increasing number of coaches and revenues, it seems like the concept is working and that the coaches are satisfied with the company. Quarterly average revenues per coach were $6,662 in the last quarter. This is obviously not a high number; however, we need to keep in mind that many coaches are only doing this part-time. Also, that number has been increasing quickly over the last few years as you can see in the picture below. I believe those numbers are proof that the business model of the company really works for its coaches.
The beauty of MLM is that growth directly translates into more growth. If a coach finds more clients, more clients will turn into more coaches who again will find more clients. And the rising revenue per coach proves that this is still possible without coaches taking market share from each other. So, even if the pandemic might have helped sales, future sales will still benefit from it even after COVID is gone.
Many consumer and market trends will help Medifast grow even more over the next few years. The company estimates a 15% long-term growth rate.
Currently, the company makes a majority of its revenues in its home market, the US. Before the COVID pandemic, Medifast also wanted to bring Optavia to Asian markets, but their plans were cut short due to the emergence of COVID and were therefore not very successful yet. However, once we have arrived at a “new normal”, there will definitely be many more growth opportunities in Asia, Europe, Australia, and possibly South America.
Furthermore, in America 70% of the population is overweight, and the number of overweight people will increase at a rate of 2% every year. Combined with people trying to live a healthier lifestyle, going forward the company will further benefit from these positive macro trends.
And finally, compared to a decade ago nowadays more and more people are more willing to join the gig economy or to have a side business. This trend will continue with growth rates of 10-15% over the next few years. Therefore, Medifast will have a larger and larger pool of people who consider becoming coaches.
Through Medifast’s business model, the company was able to slowly make its moat deeper and deeper.
Firstly, the company has a very lean overhead structure. Despite generating almost $1B in sales in 2020, the company employed only 713 employees, of which 409 worked in manufacturing. Therefore, there are only 304 employees working in marketing, administration, and other central functions (coaches don’t count as employees). Moreover, from its coach-system, the company basically gets “free” marketing and has almost no recruitment costs as coaches also do this job for “free”. All these points combined give the company a big cost advantage over its competitors.
The close relationships between customers and coaches also tend to make customers more valuable in the long term. Even more so as the company sells month-long food subscriptions instead of single products. Also, Medifast is trying to build a community around the products, in which customers and coaches all interact with each other. All these points combined make customers even more loyal to Optavia.
Furthermore, Optavia’s brand is already well known and a growing brand will also give the whole MLM structure even more credibility.
Finally, the good brand and its coaching structure allow the company to sell its products directly to customers, without having to pay retail stores or e-commerce platforms. Over 90% of the company’s revenues are via direct sales. This is yet another cost advantage over competitors who have to pay retail stores, etc.
For many years the company’s annual revenues stagnated around $300M. However, since 2018 the revenues started to grow rapidly, reaching $500M in 2018, $710M in 2019, and $930M in 2020. Below we can see that the revenues grew even faster in 2021, reaching quarterly sales of $394M in the second quarter.
Based on the company’s guidance from August this year, for the remaining two quarters the company expects sales of around $370M per quarter. This signals, a slowdown of quarter-over-quarter growth, but still is a big jump when comparing sales year over year.
As shown above, there are still many trends and growth opportunities that should ensure that the company keeps growing in the next few years.
In 2021, the company expects earnings of around $13-14, giving the company a quite low PE ratio of around 14.5. Two other very positive points need to be mentioned about the company’s profits.
The first one is that MED has proven that with increasing revenues, the company is able to use its economies of scale to grow profits even more (absolute and relative). In the chart below you can see that on the back of increasing revenues, the profit margin has increased gradually over the years. This is a very positive sign, that shows that the company doesn’t just “buy” market share by using lower prices, but instead can profit from a higher market share.
Source: Investor Presentation August – October 2021
The second point to note is that the profits are very stable (also during all the years before 2018). The reason for that is that the cost structure is very variable. Only 13% of the operating costs (as a percentage of revenues) were fixed costs.
The company’s low fixed costs ensure that even in the unlikely scenario of decreasing revenues, Medifast will still be profitable.
Balance sheet & use of profits
In a debt-heavy environment, Medifast stands out. The company has no debt at all on its balance sheet and can therefore show off its net-cash position of $192M.
The balance sheet doesn’t have many assets, as the business model is not very capital-intensive. The low cash need and an investor-friendly management have resulted in huge shareholder returns over the years. Since 2016 40% of the profits were paid out as dividends, currently giving the company a dividend yield of almost 3%. The quarterly dividend has increased by almost 500% since 2016 (from $0.25 in 2016 to now $1.42). The low payout ratio and increasing earnings give hope for further dividend raises.
The company also used around 25% of its profits to buy back shares. The remaining 35% stayed within the company, mostly to finance its rapid growth.
Valuation: 50% upside
By annualizing the EBIT from the first two quarters of the year, the company is currently trading at an EV/EBIT ratio of around 9.1.
Based on its peer's EV/EBIT multiples between 17 (food processing) and 22 (household goods), there is still a big upside for the company.
To stay conservative I will use the lower multiple (17) and use a 20% discount for Medifast’s business due to the risks that come from its MLM business structure, and I will completely ignore that the company will likely grow faster than its peers. With the resulting multiple of 13.6, the company would be valued at around $290 - an almost 50% upside from the current price. And just to stress this again, this is still a conservative estimation.
Medifast has a relatively deep moat around its business and grows rapidly. Combined with a solid balance sheet and an investor-friendly management, this stock likely is a great investment opportunity. The stock is especially interesting for dividend-growth-focused investors due to its quickly increasing 3% dividend yield and a relatively low payout ratio.
This article was written by
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